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p. 14 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world Overview of economic highlights and prospects Export or domestic demand-led growth in developing Asia? Introduction Export-led growth strategy Definition of domestic demand- and export-led growth strategies Demand-side growth-accounting exercise Decomposition analysis of stances in the private, government, and trade sectors Comparison of expenditure shares of open European countries and selected countries in the Asia-Pacific region Summary and conclusions Endnotes and references II. Economic trends and prospects in developing Asia III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : I. Developing Asia and the world

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Decomposition analysis of stances in the private, government, and trade sectors

In this section, the stances of the private sector, the government (fiscal) sector, and trade sector for the five selected countries are analyzed. (The technical details of the aggregate demand decomposition analysis are provided in Felipe and Lim, forthcoming.) The private sector stance, or direct "own" multiplier on output, is given by (Ip/sp) where Ip denotes gross private investment and sp is the savings rate out of GDP. If (Ip/sp) is larger than GDP, then private investment is larger than private savings (or, alternatively, private disposable income is smaller than private spending, composed of private consumption and private investments). Under these circumstances, the private sector is exhibiting an "expansionary stance" on aggregate demand, i.e., demand injections are larger than demand leakages. The government or fiscal stance is (G/t) where G is government spending and t is the tax effort out of GDP. If (G/t) is larger than GDP, then government spending is larger than tax revenues, and the government exhibits an expansionary stance on aggregate demand, i.e., it exerts positive net injections on aggregate demand. Finally, the external sector stance is (X/m), where X denotes exports of goods and services and m is the propensity to import out of GDP. If (X/m) is larger than GDP, exports exceed imports, and the trade or external sector is exhibiting an expansionary stance on aggregate demand, i.e., export injections exceed import leakages. The period covered in this analysis is 1983-2003, using real values in the national income accounts for aggregate demand components.

The results are presented in Figures 1.18-1.22, which plot the stances of the three sectors vis-à-vis GDP.

People's Republic of China

The PRC's slow transformation into a market economy and its participation in world trade has brought almost uninterrupted high growth to the country from the late 1970s until the present. The very high private savings rates (above 35%) have allowed the private sector "stance" to be nonexpansionary throughout most of the second and last decades, while maintaining a very high share, as well as growth, of GDCF (Figure 1.18). Since the early 1990s, the fiscal stance has been expansionary. The external stance became expansionary in 1990 and has remained positive until now. The major expansionary stances in the last decade came from the government and external sectors.

In recent years, the PRC Government has reduced the expansionary fiscal stance in an attempt to avoid overheating of the economy. This explains why the external sector has emerged as the leading expansionary sector in recent years.

India

As in the PRC, relatively high private savings rates for a low-income country have allowed a nonexpansionary private sector stance and, at the same time, have supported a GDCF of around 20-25% of GDP during most of the second and last decades. Figure 1.19 shows the consistent nonexpansionary stance of the private sector. This sector's stance falling below GDP seems to be widening in recent years as the private savings rate is close to 30% of GDP.

Imports have been increasing since the 1990s but at lower rates than in the other countries. Export growth, however, has outpaced import growth in recent years leading to smaller negative net exports and to a small nonexpansionary external stance.

The very low tax effort (below 10% of GDP during most of the 1983-2003 period) and high government spending have made the government the only sector with an expansionary stance. This impact of the fiscal expansionary stance on aggregate demand, though large and increasing in recent years, is moderated both by the growing gap between GDP and the private sector stance and by the improvement in the external stance.

Korea

Figure 1.20 shows that an expansionary private sector stance and nonexpansionary external stance during 1983-1985 were reversed in the second half of the 1980s. This shift to an expansionary external stance took place at the time the optimism about the Asian miracle was at its height. This high foreign exchange-earning capacity of the country was an important component of the country's success.

The appreciation of the won, high short-term capital inflows, speculative bubbles, and the fixed exchange rate regime of the 1990s, however, brought back an expansionary private sector despite the country's very high private savings rates. This was accompanied by a reversal to a nonexpansionary (and at times contractionary) external stance between 1990 and 1997. This contributed to a loss in confidence in Korea in the period right before the Asian crisis.

As Korea became enmeshed in the crisis, the deep recession and sharp currency depreciations in late 1997 and throughout 1998 effected a sharp reversal, with the private sector stance shifting sharply from expansionary to highly contractionary, and vice versa in the case of the external stance. This situation continues, though is quite subdued compared with the situation in 1998-1999. In recent years, Korea has experienced difficulties in increasing its GDP growth rate due to weak consumption demand. The fiscal stance has historically been nonexpansionary except in 1998-1999 as a result of the Asian crisis. Therefore, the only expansionary sector in Korea in the post-Asian crisis period has been the external sector, as net exports remain significantly positive.

Philippines

The Philippines' economic history since the 1980s has been marked by alternate periods of growth and recession. The sharp recession and crisis in the mid-1980s caused a sharp reversal in the private sector stance from highly expansionary in 1983 to highly contractionary. Correspondingly, the contractionary external stance in 1983 turned expansionary in 1985-1988.

Economic recovery in the late 1980s brought the private sector increasingly back to very positive territory in the 1990s, even though 1990-1993 were years of stagnation. The most expansionary period of the private sector was 1993-1997. Accompanying the high expansionary stance of the private sector were increasingly negative net exports, which returned in 1989 and rapidly increased in the 1990s (reaching more than 10% of GDP).

The Philippines was also hit by the Asian crisis in the second half of 1997 and throughout 1998. The sharp currency depreciation, initial high interest rates, and a slight recession tamed the high expansionary stance of the private sector (making it briefly contractionary in 1999 and 2000) and brought net exports to positive territory in 1999 and 2000.

The ensuing economic recovery (though weak and slow) returned the private sector to expansionary territory and the external sector to a contractionary position in recent years (2001 to 2003), but at much lower levels than before the Asian crisis.

High government injections and deficits in the mid-1980s were met with fiscal austerity in 1987-1992 due to debt overhang as the country joined the decade-long debt crisis that afflicted most Latin American countries during 1982-1992. Philippine fiscal deficits remained high in 1987-1992, but this is not reflected in Figure 1.21 because much of the government spending was due to debt payments, and net lending and bailouts of government corporations. Fiscal surpluses were attained in 1994-1997 but these were reversed in 1998 due to the crisis. The Philippines now faces another fiscal crisis as the tax effort has continued its decline since the crisis, and as debt payments and failing government corporations (especially the National Power Corporation) are absorbing much government spending. The fiscal stance turned expansionary in 1999, but weakly so for the reasons given just above.

Summing up, recent years in the Philippines have been marked by an expansionary stance in the private and fiscal sectors, and a contractionary one in the external sector--but even then, these levels are much lower than before the Asian crisis.

Thailand

Like Korea, Thailand's private sector stance moved from expansionary to nonexpansionary in 1985-1987, and its net exports turned from negative into positive in 1986-1987 (Figure 1.22). Net exports turned slightly negative in 1988-1989. Thus, like Korea, Thailand was at its most "miraculous" during the second half of the 1980s, when its net exports were either positive or in slightly negative territory, and its private sector was not too expansionary.

Also like Korea, currency overvaluation, high short-term capital inflows, speculative bubbles, overlending and overborrowing, and a fixed exchange rate regime made the private sector's stance significantly expansionary from 1989, which continuously strengthened during 1990-1996. Correspondingly, its external stance was significantly contractionary throughout the 1990s, especially in the few years before 1997, the year of the outbreak of the Asian crisis (which, of course, originated in Thailand).

The fiscal stance was largely nonexpansionary during 1987-1995. More so than in Korea, there were very severe private sector and trade sector adjustments during the Asian crisis and its aftermath. The private sector became very highly contractionary, especially in 1999 and 2000, and it remains significantly negative. The external stance turned very highly expansionary, especially in 1998 and 1999, and has remained that way.

The fiscal stance was expansionary (with fiscal deficits) during 1997-2000 because of a decline in the tax effort and social and economic spending due to the Asian crisis. These were restrained in 2002 and 2003 as tax efforts improved (unlike in the Philippines, where the tax effort has continued to decline).

Thailand has shown a continuous and increasing import propensity from the mid-1980s to the present, with a short respite in 1998 (because of the Asian crisis), but since then export growth has outpaced import growth. Thus, as in Korea, 2002 and 2003 saw the trade sector as the only one providing a significant expansionary stance to aggregate demand. Nevertheless, the reduction in the nonexpansionary stance of the private sector during the last few years is, to some extent, the result of Prime Minister Thaksin's policies. For the time being, the private sector stance is still nonexpansionary. However, if it becomes overexpansionary, then the authorities must be cautious that the situation does not revert to that of the precrisis period, that is, a highly expansionary private sector stance leading to significant trade deficits financed by large foreign borrowings (making the economy very vulnerable to interest and exchange rate shocks).

Therefore, despite the attempts of the prime minister at switching from export-led to domestic demand-led growth, net exports still provide a key ingredient to Thai growth, while the private sector and fiscal stances--the domestic demand sectors--have actually been nonexpansionary in recent years. If anything, Mr. Thaksin's policies must be seen as an attempt at increasing aggregate output vis-à-vis aggregate demand (domestic absorption). If one thinks of net exports (X?-?M) equivalently (through the national accounts) as the difference between aggregate output (GDP) and domestic absorption (the sum of consumption plus investment and plus government expenditures), it seems that the Government's five-pronged strategy (Box 1.3) aims to boost the former rather than the latter.

Summary

The three questions posed at the beginning of this part of ADO 2005 can now be answered.

1. Does the evidence indicate that countries are switching from export-led growth to domestic demand-driven growth?

The answer to this question is a clear "No."

The external sector is the one with the strongest expansionary stance in recent years in three out of the five countries studied, namely, PRC, Korea, and Thailand. For Korea and Thailand, it is the only sector providing an expansionary stance. For the PRC, the Government is very consciously reducing its expansionary stance to avoid overheating. Since its private sector has historically exhibited a nonexpansionary stance (due to the country's high savings rate), the trade sector provides a major force in the expansion of aggregate demand.⁹

In India, the high fiscal expansionary stance is growing, but growing nonexpansionary and offsetting pressures from the private sector and improving net exports (though still negative) are reducing this expansionary domestic demand pressure on aggregate demand.

In the Philippines, the post-Asian crisis years saw a return to expansionary stances in the private and fiscal sectors, and negative net exports, though the expansionary stance of the private sector and negative net exports are substantially lower than before the Asian crisis.

2. Did the export-led strategies partly contribute to the Asian financial crisis?

Again, the answer to this question is a clear "No."

Korea, Philippines, and Thailand followed a growth strategy characterized by a bias against exports during the years before the Asian crisis. This bias has been well documented and consisted of overvaluation of the currency, overlending and overborrowing in the domestic private sector, and creation of speculative bubbles in the nontradable sectors. This resulted in highly negative net export positions, and the exaggerated expansionary stance of the private domestic sector. For Korea and Thailand, this hurt the strong Asian miracle image they had achieved in the second half of the 1980s. The Asian crisis and its aftermath have been a painful reversal of the earlier situation in these three countries.

These results directly contradict the arguments of Palley (2002) presented earlier--namely that the export-led growth strategy was partly to blame for the Asian crisis and led to biases against the domestic demand sector. In fact, the above simple analysis has shown that it was an overexpansionary stance in the private sector and growing trade deficits that marked the immediate period before the Asian crisis for Korea, Philippines, and Thailand.

3. What lessons can be drawn from the different country experiences?

The most obvious result coming out of the above analysis is that the "best" periods for the selected countries have been those when both domestic demand and net exports exhibited impressive growth. This corroborates the earlier justifications for export-led growth, especially the argument that developing countries need precious foreign exchange to finance their import needs. It must be pointed out that this corresponds to the definition of domestic demand-led growth weakly speaking (both domestic demand and net exports are increasing). The PRC has demonstrated that this kind of growth can be sustained for long periods. India adopted this type of strategy in the late 1990s, and as a result its high domestic demand growth is accompanied by impressive export growth and improvements in its trade deficits. Thailand and Korea followed this strategy in the second half of the 1980s, when their reputation as Asian tigers was at a peak. A deviation from this strategy seemed to have led them toward the Asian crisis. The above analysis indicates that they actually have reverted to the earlier strategy of promoting both domestic demand and net export components of the economy during this postcrisis period.

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